It makes perfect sense that when entering into a new business relationship the parties (and their counsel) are keenly focused on getting things started. While there is nothing wrong with this, sometimes parties forget to memorialize, or even discuss, when, how and under what circumstances their contractual obligations will end. A recent case from the Massachusetts Appeals Court, Robert and Ardis James Foundation v. Meyers, reminds us that failing to spell out when a contract ends can result in seemingly unfair consequences.
Daniel Meyers was a shareholder in the First Marblehead Corporation, a privately held business. In 1998, First Marblehead planned to issue more stock and offered its existing equity holders the opportunity to purchase that equity, so as not to be diluted. While Meyers wanted to purchase the additional equity to which he had an option, he did not have funds with which to do so. Meyers asked his friend, Robert James, if he could provide the money needed so that Meyers could exercise his option to buy more First Marblehead stock. Eventually, Meyers and James reached an agreement, stating the following:
We have agreed that [Meyers] will exercise [his] rights to purchase [First Marblehead] stock at $20.00 per share and that you [James, through your Foundation,] will advance the funds … in return for the right to participate in the proceeds of sales.…The advances will be without recourse and will be repaid solely out of proceeds when the stock is sold.
First Marblehead went public in 2003 and in 2005 the company began issuing quarterly dividends. Not surprisingly, because the shares that James’ Foundation had enabled Meyers to purchase were in Meyers’ name, Meyers received all such dividends.
In 2006, James demanded that Meyers negotiate an unwinding of their joint interest in the First Marblehead stock. When Meyers refused, James’ Foundation sued, alleging breach of contract and breach of the implied covenant of good faith and fair dealing. The trial court sided with the Foundation, ruling that Meyers had a duty to “engage in reasonable efforts to arrive at a reasonable time for sale and thus resolve the contracts,” and that Meyers had failed to do so when he “unfairly rewarded his own interests at the expense of the reasonable expectations of the [plaintiffs].” The Appeals Court disagreed, however, noting that:
Meyers’ decision to hold the shares beyond the date of the IPO and to collect the dividends was his contractual right.…While the use of a discretionary contract right as a pretext may justify a finding of a breach of the implied covenant, [Meyers was not using his right as a pretext to extract anything from James].
The question now is can Meyers hold his First Marblehead stock forever? While the answer appears to be no, it may take another lawsuit to truly sort this out because the only guidance the Appeals Court gave in this regard was that:
[T]he agreement contemplate[s] that a sale of the shares will be effectuated, and thus, Meyers cannot refuse to sell the stock or otherwise to resolve his relationship with the plaintiffs indefinitely without violating the implied covenant of good faith and fair dealing.
So, the next time you are entering into an agreement, remember this case and plan for the end of your business relationship at the outset. If you don’t, you could end up with years of litigation and the only “resolution” being a court indicating that further litigation will be necessary.